Prompted by the regrettable Amazon spin-off series, I’m re-reading J.R.R. Tolkien’s The Lord of the Rings.
And – as 1,000-page trilogies are wont to – it’s filling my waking thoughts.
Maybe that’s why I see signs and portents in news that US creative software behemoth Adobe has agreed to buy rival Figma for $20 billion.
It doesn’t help that I’ve just got to an especially existential point in Tolkien’s tale.
Gandalf the wizard has broken a spell that has weighed down King Théoden of Rohan – one that caused him to foresee only ruin through a shadow of despair.
And almost a year since the Nasdaq index peaked then began a steep descent, tech stock investors feel you, King Théoden.
But chin up! Because as anyone who’s read Tolkien’s epic knows (and, as it’s the best-selling novel of all-time, that’s most of you), soon sunlight will stream down upon the monarch, rekindling his optimism of old.
His animal spirits, you might say.
Doom and gloom
Could Adobe’s big-ticket takeover similarly break the disenchantment of tech investors?
It’s not entirely fanciful. But for now the sector remains in a funk, even by the standards of a miserable year for nearly all assets.
True, UK-focused investors have been spared the worst. The London Stock Exchange has few of the sort of high-growth stocks that have come off the rails recently. The FTSE All-Share is down just 8% year-to-date.
That compares to a 20% slide for the US S&P 500 and 28% for the tech-heavy Nasdaq.
But most of us invest globally nowadays – with securing more exposure to the US tech stocks that have driven the past decade’s bull market being a major motivation.
Yet even here we’ve been lucky. Sort of.
Sterling has slumped 16% versus the dollar in 2022 (at the time of writing). This has had the effect of boosting the value of our overseas holdings, at least in terms of our dwindling currency.
That said, overseas losses puffed up by a plunging currency is hardly a reason to party. Our spending power has been greatly diminished versus our North American peers – though we’re doing better than the Jones’ next door if they kept all their wealth in pounds.
Also tech stocks have fallen so hard that UK investors in US-focused funds – especially those favouring innovative firms – have still been hammered, even with sterling’s decline.
The giant Scottish Mortgage Investment Trust was cut in half from its 2021 high by June this year, for example.
Even mainstream technology trusts and ETFs are down 30-40%.
A grand illusion
Sometimes it’s hard to see what could have caused a market reversal. But this time we have an abundance of culprits.
There was euphoria in the run-up, for starters.
The companies punished hardest in 2022 have been those that soared highest in the Covid era of lockdowns and home working.
As everything digital – from e-commerce to streaming to payments – boomed in 2020, pundits speculated lockdowns had pulled forward the future by a decade. Microsoft’s CEO said its customers had done two years’ worth of digital transformation in just two months.
Tech investors went wild. The price of Scottish Mortgage tripled in less than two years off its March 2020 lows.
Yet when economies reopened, it turned out sales and profits had often been pulled forward, too. Valuation multiples for digitally disruptive stocks were reconsidered in the light of earnings normalising, and consumers still being up for a long haul flight.
Then came inflation, thanks to resurgent demand and insufficient supply. Making it worse was a less sexy kind of disruption – the kind that sees shipping containers pile up at ports.
Inflation in turn caused Central Banks globally to raise interest rates.
And rates strongly influence how much investors will pay for profits in the faraway future.
It’s a kinda magic
Post-Covid reality looking rather like pre-Covid reality, inflation rampant, and interest rates competitive again.
No wonder growth stocks cratered.
Which brings us back to where we started on today’s quest – with Adobe’s acquisition of creative software rival Figma.
With a $20 billion price tag, this was hardly a gulp by a bottom feeder. In fact it’s reportedly the most ever paid to acquire a venture capital-backed company.
But it’s Figma’s price as a multiple of sales that is most instructive.
You see, Figma – which is still doubling sales year-over-year – is one of the generation of Software as a Service (SaaS) outfits that became ultra-prized in the home-working era.
While most US companies in the last bull market were re-rated to ever higher multiples of earnings or sales, SaaS companies became loftily valued on the basis of their Annual Recurring Revenue (ARR).
ARR is often presumed to be stable and predictable – almost like a tech stock annuity. People will pay up for presumed certainty.
And Adobe has just paid around 50-times Figma’s ARR to buy the company.
No, not 50-times profits. Not even 50-times traditional sales. 50-times ARR.
This is a sky-high value valuation by the standards of old-school investing. Yet at the peak of the lockdown mania many fast-growing tech firms were trading at such crazy multiples.
That was mostly how a company like video call sensation Zoom saw its shares go from $67 at the start of 2020 to nearly $560 by October that year. It’s back to $76 as I write.
Abracadabra
But given what Adobe sees in Figma… were those valuation multiples really so ‘crazy’?
Adobe should know its market as well as any investor or analyst. Its execs have been battling the brash upstart Figma for years and have now seemingly thrown in the towel. They surely guessed the market would take fright at the size of the deal – Adobe’s shares are down more than 20% since it was announced – yet they did it anyway.
Clearly, they believe paying 50-times ARR was worth it.
In contrast, the market presumably thinks either Figma isn’t worth $20 billion or – worse – that this deal smacks of desperation.
Maybe Adobe’s core business faces more competition than previously thought?
However, a more optimistic lens might view the deal as revealing that fast-growing and innovative technology really are worth paying for.
Maybe not what tech investors would stump up in 2021 (I don’t think Peloton’s shares are coming back any time soon…) and maybe not even what Adobe is prepared to pay to turn this potentially lethal competitor into another product line.
But possibly much more than such shares are now trading for, after their steep reversals.
If so, this could be as close as we’ll get to somebody ringing the bell for the bottom.
Magical thinking? Maybe. With war raging and central banks continuing to aggressively hike rates I wouldn’t expect a fairytale transformation from bear back to bull in a blink.
But as Tolkien wrote of weightier matters: “In the end it’s only a passing thing, this shadow; even darkness must pass.”
As goes demonic overlords, so go bear markets.
